CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY INFORMATION YEARS ENDED
TABLE OF CONTENTS YEARS ENDED INDEPENDENT AUDITORS REPORT 1 CONSOLIDATED FINANCIAL STATEMENTS CONSOLIDATED BALANCE SHEETS 3 CONSOLIDATED STATEMENTS OF INCOME 4 CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY 5 CONSOLIDATED STATEMENTS OF CASH FLOWS 6 7 INDEPENDENT AUDITORS REPORT ON SUPPLEMENTARY INFORMATION 21 SUPPLEMENTARY INFORMATION CONSOLIDATING BALANCE SHEET 22 CONSOLIDATING STATEMENT OF INCOME 23 CONSOLIDATING SCHEDULE OF OPERATING EXPENSES 24 REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING AND ON COMPLIANCE AND OTHER MATTERS BASED ON AN AUDIT OF FINANCIAL STATEMENTS PERFORMED IN ACCORDANCE WITH GOVERNMENT AUDITING STANDARDS 25
INDEPENDENT AUDITORS REPORT Board of Directors McNally Smith College, Inc. and Subsidiary Saint Paul, Minnesota We have audited the accompanying consolidated balance sheet of McNally Smith College, Inc. and Subsidiary (the College) as of December 31, 2010, and the related consolidated statements of income, shareholders equity, and cash flows for the year then ended. These financial statements are the responsibility of the College s management. Our responsibility is to express an opinion on these financial statements based on our audit. The financial statements of McNally Smith College, Inc. as of December 31, 2009, were audited by other auditors whose report dated March 31, 2010, expressed an unqualified opinion on those statements. As discussed in Note 11, the College has restated its 2009 financial statements during the current year to record capital leases, non-compete agreements and environmental remediation in conformity with accounting principles generally accepted in the United States of America. The other auditors reported on the 2009 financial statements before the restatement. We conducted our audit in accordance with auditing standards generally accepted in the United States of America and the standards applicable to financial audits contained in Government Auditing Standards issued by the Comptroller General of the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of McNally Smith College, Inc. and Subsidiary as of December 31, 2010, and the results of its operations and its cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. Our audit was conducted for the purpose of forming an opinion on the basic financial statements taken as a whole. The accompanying footnote 12 on the institutions calculation on its Title IV 90/10 revenue test are required by the U.S. Department of Education and are presented for purposes of additional analysis and are not a required part of the basic financial statements. (1) An independent member of Nexia International
Board of Directors McNally Smith College, Inc. and Subsidiary In accordance with Government Auditing Standards, we have also issued our report dated May 5, 2011 on our consideration of McNally Smith College, Inc.'s internal control over financial reporting and on our tests of its compliance with certain provisions of laws, regulations, contracts, and grant agreements and other matters. The purpose of that report is to describe the scope of our testing of internal control over financial reporting and compliance and the results of that testing, and not to provide an opinion on internal control over financial reporting or on compliance. That report is an integral part of an audit performed in accordance with Government Auditing Standards and should be considered in assessing the results of our audit. We also audited the adjustments described in Note 11 that were applied to restate the 2009 financial statements. In our opinion such adjustments are appropriate and have been properly applied. Minneapolis, Minnesota May 5, 2011 LarsonAllen LLP (2)
CONSOLIDATED BALANCE SHEETS ASSETS 2009 2010 (Restated) CURRENT ASSETS Cash and Cash Equivalents $ 791,798 $ 894,867 Accounts and Loans Receivable, Net 602,917 336,794 Prepaid Expenses 264,609 124,446 Inventories 156,276 209,461 Other Receivables 38,920 47,195 Total Current Assets 1,854,520 1,612,763 LONG-TERM LOANS RECEIVABLE (Net of Current Maturities) 17,605 - PROPERTY AND EQUIPMENT, Net 12,158,416 11,004,501 OTHER ASSETS, Net 128,237 188,384 Total Assets $ 14,158,778 $ 12,805,648 LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES Current Maturities of Long-Term Debt $ 751,379 $ 715,639 Accounts Payable - Trade 70,951 118,649 Accrued Expenses 752,676 531,320 Accrued Distributions 200,000 - Unearned Revenues 1,144,831 747,987 Environmental Remediation Liability 135,013 125,945 Total Current Liabilities 3,054,850 2,239,540 LONG-TERM DEBT (Net of Current Maturities) 5,122,330 4,933,298 Total Liabilities 8,177,180 7,172,838 SHAREHOLDERS' EQUITY Common Stock, No Par ($1 Stated Value), 25,000 Shares Authorized, 1,000 Outstanding 1,000 1,000 Additional Paid-In Capital 68,673 68,673 Retained Earnings 5,911,925 5,563,137 Total Shareholders' Equity 5,981,598 5,632,810 Total Liabilities and Shareholders' Equity $ 14,158,778 $ 12,805,648 See accompanying Notes to Consolidated Financial Statements. (3)
CONSOLIDATED STATEMENTS OF INCOME YEARS ENDED 2009 2010 (Restated) Percent Percent Amount of Sales Amount of Sales REVENUES Gross Tuition Revenues $ 15,565,204 100.7 % $ 13,800,127 100.8 % Less: Scholarships and Discounts (903,684) (5.8) (775,300) (5.7) Tuition Revenues, Net 14,661,520 94.8 13,024,827 95.1 Dorm Rental Income 153,900 1.0 - - Retail Sales 648,746 4.2 671,807 4.9 Total Revenues 15,464,166 100.0 13,696,634 100.0 DIRECT COSTS Instruction Salaries 4,125,732 26.7 3,568,035 26.1 Other Direct Costs 158,655 1.0 152,245 1.1 Retail Cost of Sales 706,494 4.6 599,923 4.4 Total Direct Costs 4,990,881 32.3 4,320,203 31.5 GROSS MARGIN 10,473,285 67.7 9,376,431 68.5 OPERATING EXPENSES 9,234,768 59.7 8,339,976 60.9 INCOME FROM OPERATIONS 1,238,517 8.0 1,036,455 7.6 OTHER INCOME (EXPENSE) Other Income (Expense) (52,113) (0.3) 9,909 0.1 Loan Prepayment Penalties (184,660) (1.2) - - Interest Expense (357,956) (2.3) (402,550) (2.9) Total Other Expense (594,729) (3.8) (392,641) (2.9) NET INCOME $ 643,788 4.2 $ 643,814 4.7 See accompanying Notes to Consolidated Financial Statements. (4)
CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY YEARS ENDED Additional Total Common Paid-In Retained Shareholders' Stock Capital Earnings Equity BALANCE, DECEMBER 31, 2008, As Previously Reported $ 1,000 $ 68,673 $ 5,459,488 $ 5,529,161 Effect of Restatement (Note 11) - - (274,299) (274,299) BALANCE, DECEMBER 31, 2008, as Restated 1,000 68,673 5,185,189 5,254,862 Net Income - - 643,814 643,814 Distributions - - (265,866) (265,866) BALANCE, DECEMBER 31, 2009, as Restated 1,000 68,673 5,563,137 5,632,810 Net Income - - 643,788 643,788 Distributions - - (295,000) (295,000) BALANCE, DECEMBER 31, 2010 $ 1,000 $ 68,673 $ 5,911,925 $ 5,981,598 See accompanying Notes to Consolidated Financial Statements. (5)
CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED 2009 2010 (Restated) CASH FLOWS FROM OPERATING ACTIVITIES Net Income $ 643,788 $ 643,814 Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities: Depreciation and Amortization 1,120,492 886,611 Allowance for Doubtful Accounts (47,597) (232,000) (Increase) Decrease in Current Assets: Accounts Receivable (218,526) 165,256 Prepaid Expenses (140,163) 122,613 Inventories 53,185 130,427 Other Receivables 8,275 17,341 Increase (Decrease) in Current Liabilities: Accounts Payable (47,698) (153,752) Accrued Expenses 230,424 149,252 Unearned Revenues 396,844 (275,087) Net Cash Provided by Operating Activities 1,999,024 1,454,475 CASH FLOWS FROM INVESTING ACTIVITIES Purchase of Property and Equipment (2,113,862) (515,213) Net Change in Loans Receivable (17,605) - Non-Compete Agreement Payment - (250,000) Collection of Note Receivable from Shareholders - 258,331 Net Cash Used by Investing Activities (2,131,467) (506,882) CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from Long-Term Debt 1,523,216 1,529,174 Payments on Long-Term Debt (898,444) (2,200,913) Net Change in Line of Credit (400,000) - Loan Closing Costs (100,398) - Distributions Paid to Shareholders (95,000) (265,866) Net Cash Provided (Used) by Financing Activities 29,374 (937,605) NET INCREASE (DECREASE) IN CASH (103,069) 9,988 Cash - Beginning of Year 894,867 884,879 CASH - END OF YEAR $ 791,798 $ 894,867 SUPPLEMENTAL DISCLOSURES Cash Paid for Interest $ 333,302 $ 402,550 Non-Cash Transactions: Refinanced Debt $ 2,874,184 $ - Accrued Distributions $ 200,000 $ - See accompanying Notes to Consolidated Financial Statements. (6)
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Nature of Business McNally Smith College, Inc. does business as McNally Smith College of Music and operates from its location in Saint Paul, Minnesota. The College prepares students for a fulfilling future in the global music industry by providing a culture of learning that enables them to reach their creative, intellectual and personal potential, and enriches our society through their artistry and leadership. The College markets to potential students worldwide. The College also sells musical instruments, textbooks and other music items to its students and faculty. MSCM Housing, LLC was created in 2010 to operate student housing for the benefit of the College s students. The LLC is a wholly owned subsidiary of the College. Principles of Consolidation The consolidated financial statements include the accounts of McNally Smith College, Inc. and MSCM Housing, LLC (collectively, the College). All significant balances and transactions between the two entities eliminated. Revenue Recognition The College s tuition revenues consist of tuition, application and graduation fees and retail sales which consist of bookstore, publication and cafeteria sales. Tuition revenue is deferred and recognized as revenue ratably over the period of instruction. If a student withdraws or drops out, the College follows its refund policy, which provides a 100% refund through the second week, 75% through the third week, 50% through the fourth week, 25% through the fifth week, and no refund thereafter. The College does not recognize revenue for students who enroll but never take a course. Refunds are recorded as a reduction of revenue in the period that the student withdraws from a course. If a partial refund is given to a student in accordance with the College refund policy, the portion of the revenue which has been earned by the College is recognized over the remaining period of instruction. Scholarships issued by the College are recorded as a reduction in revenue in the period that the scholarship is issued. Unearned revenues consist of tuition and housing revenues that have not been earned. Cash and Cash Equivalents The College considers all highly liquid marketable securities with maturities of three months or less at the time of purchase to be cash equivalents. Cash equivalents are carried at market value. A certificate of deposit in the amount of $500,000 as of December 31, 2009 was included in cash and cash equivalents. The certificate earned interest at.2% at December 31, 2009 and was redeemed during 2010. (7)
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Concentrations of Credit Risk The College maintains cash balances at a national bank which is insured by the Federal Deposit Insurance Corporation up to $250,000. At times, the College s uninsured cash balances may exceed the maximum FDIC insurance threshold. However, management believes this risk is minimal since the bank is considered sound and is one of the largest financial institutions in the United States. Financial instruments that potentially subject the College to credit risk consist principally of accounts receivable for which no collateral is required. Management believes that the credit risk related to accounts receivable is limited due to the large number and diversity of students that comprise the College s customer base. The College s credit risk with respect to these accounts receivable is mitigated through the participation of a majority of the students in federally funded financial aid programs. Accounts and Loans Receivable and Allowance for Doubtful Accounts Accounts receivable consist of uncollateralized student obligations due under the College s tuition policy which generally requires tuition payments within five weeks of the beginning of a semester and student loans. No interest is charged on the account receivable balances. During 2010, the College started a loan program which offers students an alternative for those students who might not otherwise qualify for a loan. The loan program consists of either a 12-month option in which no interest is charged or up to a 10-year option in which interest is charged at 8%. The College reduces accounts and loans receivable by a valuation allowance that reflects management's estimate of the amounts that will not be collected because of the inability, failure or refusal of its students to make required payments. The College determines its allowance for doubtful accounts amount based on an analysis of the accounts receivable and loan detail, historical write-off experience, and current economic conditions, recoveries and trends. Accounts past due more than 90 days are individually analyzed for collectibility. When all collection efforts have been exhausted, the accounts are written off against the related allowance. Bad debt expense is recorded as an operating expense in the statements of income. Inventories Inventories are stated at the lower of cost or market on a first-in first-out basis, and consist primarily of books and other items sold in the College s bookstore and food items sold in its cafeteria. (8)
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Property and Equipment Property and equipment are stated at cost. The College capitalizes assets with a cost over $1,000 and a useful life of more than one year. Depreciation is provided using the straightline method over the estimated useful lives of the assets, as follows: Years Buildings and Improvements 39 Leasehold Improvements 5 Equipment, Furniture and Fixtures 5 to 10 Software 3 to 7 Vehicles 5 Website 3 Maintenance and repairs are expensed as incurred. Major renewals and betterments are capitalized. As items of property or equipment are sold or retired, the related cost and accumulated depreciation are removed from the accounts and any gain or loss is included in operating income. Other Assets Non-Compete Agreements The College capitalizes the costs associated with a non-compete agreement and amortizes the costs over the term of the agreement of two years using the straight-line method. Impairment of Long-Lived Assets The College reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to undiscounted future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. The College had no impaired assets or impairment charges in 2010 or 2009. Advertising The College expenses the costs of advertising as incurred. Advertising expense for the years ended December 31, 2010 and 2009 was $449,634 and $578,367, respectively. Income Taxes The College adopted the income tax standard for uncertain tax positions on January 1, 2009. The implementation of this standard had no impact on the College s financial statements. The College s 2007 to 2010 tax years are open for examination by the federal and state authorities. (9)
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Income Taxes (Continued) The Company has elected to be taxed under S corporation rules; therefore, it is not taxed as a separate entity. The portion of income or loss derived by the shareholders is included in their individual income tax returns. Therefore, no provision for income taxes is included in these financial statements. The entities do not incur income taxes. Instead, they file consolidated federal and state tax returns, with consolidated taxable income included in the tax returns of the parent's shareholders and are taxed accordingly. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts in the financial statements and accompanying notes. Actual results could differ from those estimates. Reclassifications Certain reclassifications have been made to the December 31, 2009 financial statements to conform with the December 31, 2010 presentation. These classifications have no effect on retained earnings or net income as previously reported. Subsequent Events The College has reviewed and evaluated subsequent events and transactions for material subsequent events through May 5, 2011, the date the financial statements were available to be issued. NOTE 2 ACCOUNTS AND LOANS RECEIVABLE Accounts and loans receivable consist of the following at December 31: 2010 2009 Student Accounts Receivable $ 495,906 $ 353,679 Student Loans Receivable 163,981 - Other Receivables 20,635 90,712 Total 680,522 444,391 Less: Allowance for Doubt Accounts (60,000) (107,597) Total Student and Loans Receivable $ 620,522 $ 336,794 (10)
NOTE 2 ACCOUNTS AND LOANS RECEIVABLE (CONTINUED) The accounts and loans receivable are presented on the balance sheet at December 31 as follows: 2010 2009 Current Portion Student and Loans Receivable $ 602,917 $ 336,794 Long-Term Loans Receivable 17,605 - Total Student and Loans Receivable $ 620,522 $ 336,794 The loans receivable will mature as follows: 2010 2009 Amounts Due in: Less Than One Year $ 146,376 $ - One to Five Years 10,500 - Greater Than Five Years 7,105 - Total Student Loans Receivable $ 163,981 $ - NOTE 3 PROPERTY AND EQUIPMENT Property and equipment consist of the following: 2009 2010 (Restated) Land $ 4,000,000 $ 4,000,000 Building and Improvements 6,631,396 5,553,235 Leasehold Improvements 139,053 139,053 Equipment and Furniture 5,231,218 4,292,822 Software and Website 411,392 305,345 Total 16,413,059 14,290,455 Accumulated Depreciation (4,254,643) (3,285,954) Total $ 12,158,416 $ 11,004,501 Depreciation expense was $959,947 and $787,636 for the years ended December 31, 2010 and 2009, respectively. (11)
NOTE 4 OTHER ASSETS Other assets consist of: 2009 2010 (Restated) Non-Compete Agreements $ 250,000 $ 250,000 Loan Fees 100,398 35,505 Organization Costs 3,678 - Trademark 495 495 Total 354,571 286,000 Accumulated Amortization (226,334) (97,616) Total $ 128,237 $ 188,384 Loan closing costs are amortized using the straight-line method over the 20-year term of the loan. The trademark is being amortized over 15 years using the straight-line method. Amortization expense was $143,819 and $95,363 for the years ended December 31, 2010 and 2009, respectively. NOTE 5 LONG-TERM DEBT Long-term debt consisted of the following: Description 2010 2009 Note payable bank, interest only payments through March 2012. After which monthly interest and principal payments of $19,822 are due with the exception of interest only payments for the months of June, July and August. Interest is fixed at 5.95% through July 2015 at which time the interest shall accrue at 3.6% + LIBOR (5.95% at December 31, 2010). The note shall become due August 2020. Secured by all assets of the College and guaranties by the owners. $ 2,778,000 $ - Note payable bank, interest only payments through June 2011 at which time the entire principal balance is expected to be re-financed over twenty years with an SBA loan. Interest at a referenced rate plus.5% (4.25% at December 31, 2010). Secured by all assets of the College and guaranties by the owners. 277,883 - (12)
NOTE 5 LONG-TERM DEBT (CONTINUED) Description 2010 2009 Note payable bank, monthly payments of principal of $20,135 plus interest at a referenced rate plus.5%, through February 2012 (4.25% at December 31, 2010). Secured by all assets of the College and guaranties by the owners. 302,027 - Note payable bank, interest only payments through March 2012, after which monthly installments of $17,285, including interest at 6% through February, 2014. Secured by all assets of the College and guaranties by the owners. 390,763 - Note payable bank, monthly payments of principal of $15,556 plus interest at a referenced rate plus.5% through October 2013 (4.25% at December 31, 2010). Secured by all assets of the College and guaranties by the owners. 544,444 - Revolving note payable bank, interest only payments through August 2012 at which time the entire principal balance becomes due. Interest at a referenced rate plus.5% (4.25% at December 31, 2010). Secured by all assets of the College and guaranties by the owners. 350,000 - Note payable bank, payable in monthly installments of $533, including interest at 4.79%, through August 2015. Secured by a vehicle. 25,777 - SBA note payable bank, payable in monthly installments of $10,090, including interest at 5.74%, through July, 2022. Secured by building and land. 911,298 965,297 Debt refinanced in current year - monthly installments of $45,868, including interest from 4.8% - 8.4% - 4,082,199 Note payable bank, payable in monthly installments of $9,789, including interest at 7.25%, through July, 2012. Secured by building and land. - 970,730 Note payable bank, due in monthly interest-only payments at 5% through February, 2011. Secured by equipment. - 750,000 (13)
NOTE 5 LONG-TERM DEBT (CONTINUED) Description 2010 2009 Note payable bank, due in monthly installments of $5,114, including interest at 8.1%, through July, 2027. Secured by equipment. - 568,458 Note payable bank, due in monthly interest-only payments at 5% through February, 2011. Secured by certificate of deposit. - 500,000 Note payable bank, due in monthly installments of $3,476, including interest at 8.4%, through August, 2021. Secured by equipment. - 381,905 Note payable City of St. Paul, Minnesota (STAR loan), due in monthly installments of $3,652, including interest at 5.5%, through August, 2021. Secured by a building and real estate. - 374,769 Note payable bank, due in monthly installments of $9,016, including interest at 6.4%, through January 2012. Secured by equipment. - 202,276 Note payable bank, due in monthly installments of $5,573, including interest at 4.8%, through January 2013. Secured by equipment. - 186,551 Note payable bank, due in monthly installments of $2,807, including interest at 5.75%, through July 2012. Secured by equipment. - 80,248 Note payable -- bank, due in monthly installments of $4,441, including interest at 7.25%, through December, 2010. Secured by equipment. - 51,262 Note payable bank, payable in monthly installments of $2,000, including interest at 4.95%, through August 2010. Secured by equipment. - 16,000 Note payable finance company, due in monthly installments of $567, including interest at 8.18%, through April, 2012. Secured by a vehicle. 8,089 14,419 (14)
NOTE 5 LONG-TERM DEBT (CONTINUED) Description 2010 2009 Note payable - finance company, due in monthly installments of $507, including interest at 8.99%, through February, 2012. Secured by a vehicle. 6,719 11,947 Capital Leases Payable 278,709 575,075 Total 5,873,709 5,648,937 Less: Current Maturities of Long-Term Debt (751,379) (715,639) Total Long-Term Debt, Net of Current Maturities $ 5,122,330 $ 4,933,298 Certain debt agreements require the College to maintain minimum levels of net worth and debt service coverage with which the College was in compliance as of December 31, 2010. All debt not secured by equipment is guaranteed by the shareholders of the College. Under the terms of an SBA 504 loan commitment dated August 6, 2010, the College may borrow up to $564,000 at an interest rate expected to be approximately 6%. The College intends to use a portion of the proceeds to re-finance the $277,883 note current payable to a bank and accordingly, that amount has been classified as long-term debt in the December 31, 2010 balance sheet. The College has a revolving credit promissory note with a bank. The revolving note is for a total of $750,000 with interest at a referenced rate plus.5% (4.25% at December 31, 2010) and expires on August 1, 2012. At December 31, 2010, the College was indebted to the bank on this revolving note for $350,000 and is included in the notes above. There was no balance due on this revolving note at December 31, 2009. The College also has an equipment revolving credit promissory note with a bank. The revolving note is for a total of $750,000 with interest at a referenced rate plus.5% (4.25% at December 31, 2010) and expires on July 1, 2011. At December 31, 2010 and 2009, there was no amount outstanding on this revolving note. The revolving note is secured by all assets of the College and guaranties by the owners. Maturities of long-term debt, including the short-term debt expected to be refinanced, are as follows: Year Ending December 31, Amount 2011 $ 751,379 2012 931,398 2013 526,644 2014 201,300 2015 173,848 Thereafter 3,289,140 Total $ 5,873,709 (15)
NOTE 6 LEASE COMMITMENTS The College is a party to various non-cancelable lease agreements involving equipment. The College's equipment held under capital leases in the balance sheets consists of the following: 2010 2009 Equipment $ 1,226,494 $ 1,226,494 Less: Accumulated Amortization (974,984) (691,132) Total $ 251,510 $ 535,362 Included in depreciation is $283,852 of capital lease amortization pertaining to this equipment for the years ended December 31, 2010 and 2009. In addition, the College leases its administrative offices and certain office equipment under various non-cancelable operating leases. Future minimum lease commitments under these leases as of December 31, 2010 are as follows: Year Ending December 31, Capital Operating 2011 $ 258,868 $ 603,631 2012 33,783 348,198 Total Minimum Lease Payments 292,651 $ 951,829 Less: Amount Representing Interest 13,942 Capitalized Lease Obligations $ 278,709 Total rent expense and related operating expense under operating leases for 2010 and 2009 were $342,554 and $264,100, respectively. The College subleases a portion of its instructional building to a Not-for-Profit organization under a non-cancelable lease that expires 2012. Future minimum lease payments to be received under the lease is: Year Ending December 31, Amount 2011 $ 95,000 2012 42,500 Total $ 137,500 Total rent income under subleases was $158,088 and $64,000 in 2010 and 2009, respectively. (16)
NOTE 7 ENVIRONMENTAL REMEDIATION The College owns a building on campus that contains asbestos in various forms. At this time, the College has no plans to renovate or demolish these buildings over their estimated remaining useful lives. However, in accordance with the standard on asset retirement and environmental obligations, management has estimated the cost of any potential obligation to remove asbestos. The College used a future value rate assumption of 3% and discounted the estimate to present value using a risk-free rate of return of 7.2%. The College has estimated the cost of remediation to be approximately $135,013 and $125,945 and has recorded this amount as a liability on the statement of financial position at December 31, 2010 and 2009, respectively. NOTE 8 DEFINED CONTRIBUTION PLAN The College sponsors an employee retirement savings plan that qualifies under Section 401(k) of the Internal Revenue Code. The plan provides eligible employees with an opportunity to make tax-deferred contributions in a long-term investment and savings program. All employees who have two months of service and are age twenty-one or older may choose to participate in the plan. The plan allows the College to consider making a discretionary contribution; however, there is no requirement that it do so. The College s contribution was $75,000 and $60,000 for the years ended December 31, 2010 and 2009, respectively. NOTE 9 SHAREHOLDER STOCK PURCHASE AGREEMENT The shareholders entered into a Buy-Sell Agreement in June 1999, which was amended by three subsequent amendments. Among other matters, the agreement governs how shares are disposed of upon death of a shareholder, voluntary transfer or termination of employment, and involuntary transfer or disability, as defined in the agreement. The agreement provides that upon the death of a shareholder, the surviving shareholder shall purchase the shares from the estate of the deceased shareholder. In order to provide a source of funds to carry out the obligations under the agreement, each shareholder is required to obtain a life insurance policy on the other shareholder in a mutually agreeable amount. The death benefit on the term life insurance policies in place on each shareholder as of December 31, 2010 and 2009 was $5,000,000. The agreement specifies that the shareholders will stipulate a value of the business, which they determined was $10,000,000 as of December 31, 2010. The agreement also states that the purchase price of the shares will be the greater of the insurance death benefit on the life of the shareholder or the fair market value of the shares. The fair market value of the shares will be determined by an independent appraiser as selected in accordance with the terms of the agreement. (17)
NOTE 10 COMMITMENTS AND CONTINGENCIES Incentive Compensation In August 2009, the College entered into an employment agreement with the President of the College that provides annual cash incentive compensation and a Value Growth Compensation bonus based on the increase in the value of the College as defined by a formula in the agreement. The cash bonus is equal to $10,000 if net income before incentive compensation bonus is between $450,000 to $549,999, $20,000 if the net income before incentive compensation bonus is between $550,000 to $649,999 or $30,000 plus 10% of net income in excess of $650,000 if the net income before the incentive compensation bonus is $650,000 or greater. The Value Growth Compensation incentive amount is defined as 20% of the increase in the threshold amount for Value Growth Compensation, as defined in the agreement. The cash bonus is paid annually and the Value Growth Compensation benefit vests equally over a three-year period beginning in the year ending December 31, 2010 and is paid upon termination of the President s employment. Cash incentive compensation expense was $32,600 and $20,000 in 2010 and 2009, respectively, and there was no Value Growth Compensation bonus. NOTE 11 RESTATEMENT During the current year, it was discovered that certain equipment leases that should have been recorded as capital leases were recorded as operating leases. Accordingly, an adjustment was made to record the leases as capital leases as of January 1, 2009. An entry was made to record equipment of $1,226,494, accumulated depreciation of $407,279 and capital lease payable of $986,799. A corresponding entry was made to reduce previously reported retained earnings by $167,584. During 2009, an additional $283,852 of depreciation expense and $71,711 of interest expense was recorded on the statement of income and equipment lease expense was reduced by $483,434. Also during the current year, it was discovered that non-compete agreements were being amortized over the tax life of the agreement rather than the life of the agreement. An adjustment was made to record the non-compete agreements correctly as of January 1, 2009. An entry was made for $120,000 to reduce the non-compete agreements and $43,658 to adjust the accumulated amortization. A corresponding entry was made to reduce previously recorded retained earnings by $76,342. During 2009, amortization expense was reduced by $8,000 on the statement of income. Lastly, it was discovered that no liability for the environmental remediation was recorded in prior years. An adjustment was made to record an asset of $101,770, accumulated depreciation of $15,266, environmental remediation liability of $116,877. A corresponding entry was made to reduce previously recorded retained earnings by $30,373. During 2009, an additional $9,068 of accretion expense and $2,544 of depreciation expense was recorded on the statement of income. (18)
NOTE 12 REGULATORY Department of Education Requirements for Title IV Aid As a condition of eligibility to participate in the various federal financial assistance programs, the College is required to maintain financial responsibility, as defined in 34 CRF, Part 668. In accordance with 34 CRF, Part 668, financial responsibility is defined as a composite score standard greater than or equal to 1.5. A composite score of 1.0 to less than 1.5 will be subject to additional monitoring. A composite score less than 1.0 will be required to submit financial guarantees. As of December 31, 2010 and 2009, the College s composite score, as defined by the Department of Education financial condition test, was 1.6 and 1.9, respectively. In accordance with 34 CFR, (Section) 600.5 (a) (8), no more than 90% of the College s cash basis tuition and fees can be derived from Title IV funds. For the year ended December 31, 2010, the College s cash basis tuition and fees derived from Title IV funds were as follows: Cash Basis Tuition and Fees $ 14,564,402 Cash Basis Tuition and Fees Derived from Title IV 7,692,781 Percent 52.8% The composition of the above amounts is as follows: Revenue by Source Adjusted Student Title IV Revenue Subsidized Loans $ 2,091,082 Unsubsidized Loans (up to Pre-ECASLA Loan Limit) 1,995,361 PLUS Loans 2,417,151 Federal Pell Grant 925,243 FSEOG 125,550 Federal ACG Grant 24,443 Federal SMART Grant 21,500 Federal Work Study 92,451 Total 7,692,781 Title IV Revenue Adjustment - Adjusted Student Title IV Revenue $ 7,692,781 (19)
NOTE 12 REGULATORY (CONTINUED) Title IV Aid 90/10 Revenue Test Non-Title IV Revenue Grant Funds from Non-Federal Public Agencies or Private Sources $ 431,089 Funds Provided Under a Contractual Arrangement with a Federal - State, or Local Government Agency - Funds from Savings Plans for Educational Expenses that Qualify - for Special Tax Treatment Under the Internal Revenue Code - Institutional Scholarships Disbursed to the Student 817,477 Unsubsidized Loans (Over Pre-ECASLA Limit) - Student Payments 5,467,670 Student Non-Title IV Revenue $ 6,716,236 Revenue From Other Sources Activities Conducted by the Institution that are Necessary for Education and Training $ - Funds Paid to the Institution by, or on Behalf of, Students for Education and Training in Qualified Non-Title IV Eligible Programs - The Net Present Value (NPV) of Institutional Loans Disbursed to Students 155,385 Revenue From Other Sources $ 155,385 (20)